A Rational Incentives-Based Explanation for Booms and Busts: The Case of Roll-Ups

Abstract

We explore how the misaligned incentives of underwriters and investors can contribute to boom-and-bust cycles in capital market transactions. Underwriters, whose rewards are transaction-driven and largely front-loaded, have incentives to complete deals to generate fees. Investors, who base their estimates of return in part on information about past deal performance, have incentives to invest in deals with high expected returns. If the performance of deals changes over time, investors' reliance on information from past deals means they may under- or over-commit capital relative to what hindsight indicates would have been optimal. We examine this explanation using roll-ups from the 1990s.

Keywords: Booms and busts, incentives, roll-ups

JEL Classification: G30, G14, G24